GABAergic interneuron hypofunction is hypothesized to underlie hippocampal dysfunction in schizophrenia. Here, we use the cyclin D2 knockout (Ccnd2(-/-)) mouse model to test potential links between hippocampal interneuron deficits and psychosis-relevant neurobehavioral phenotypes. Ccnd2(-/-) mice show cortical PV(+) interneuron reductions, prominently in hippocampus, associated with deficits in synaptic inhibition, increased in vivo spike activity of projection neurons, and increased in vivo basal metabolic activity (assessed with fMRI) in hippocampus. Ccnd2(-/-) mice show several neurophysiological and behavioral phenotypes that would be predicted to be produced by hippocampal disinhibition, including increased ventral tegmental area dopamine neuron population activity, behavioral hyperresponsiveness to amphetamine, and impairments in hippocampus-dependent cognition. Remarkably, transplantation of cells from the embryonic medial ganglionic eminence (the major origin of cerebral cortical interneurons) into the adult Ccnd2(-/-) caudoventral hippocampus reverses these psychosis-relevant phenotypes. Surviving neurons from these transplants are 97% GABAergic and widely distributed within the hippocampus. Up to 6 mo after the transplants, in vivo hippocampal metabolic activity is lowered, context-dependent learning and memory is improved, and dopamine neuron activity and the behavioral response to amphetamine are normalized. These findings establish functional links between hippocampal GABA interneuron deficits and psychosis-relevant dopaminergic and cognitive phenotypes, and support a rationale for targeting limbic cortical interneuron function in the prevention and treatment of schizophrenia.